In Gold We Trust - From Aurophobia To Valuation

"Even though the consensus is convinced that the gold bull market has ended, we remainfirmly of the opinion that the fundamental argument in favor of gold remains intact. There exists no back-test for the current financial era. Never before have such enormous monetary policy experiments taken place on a global basis. If there ever was a need for monetary insurance, it is today."

We are happy to once again present the annual gold report by Ronald-Peter Stoeferle and his co-author Mark Valek. Although Ronald is no longer with Erste Group in Vienna (he is now a managing partner at Incrementum AG in Liechtenstein), he still writes the 'In Gold We Trust' report for Erste Group in his role as an external advisor. The version of the report that we are offering for download here is the extended Incrementum version, which inter alia contains a section on gold stocks and a number of elaborations on topics which are not as extensively discussed in the shorter version.

In spite of this year's decline in the gold price, we still trust in gold, one might say. There are a few valid reasons for the recent bearish trend, some of which Ronald dissects; nevertheless, the bet remains that it is very likely undergoing a large degree correction in a secular bull market.

As we have already remarked on occasion of previous editions, Ronald was and remains one of the very few analysts working at a mainstream institution (or in this case as an external advisor to one), who truly understand how the gold market works in terms of price formation and how it should therefore be analyzed. In chapter 3 of the report, this topic is thoroughly examined, including the fact that gold's high stock-to-flow ratio is precisely what gives it its importance as a monetary asset (and is a major reason why it was chosen as money, i.e., the general medium of exchange, in times past, before governments imposed fiat money). Chapter 3 also contains an interesting subsection on 'aurophobia' and its psychological roots.

Financial repression also receives an in-depth look in this year's report. The term was rediscovered by Carmen Reinhart and Belen Sbrancia and describes the many ways in which governments that have accumulated too much debt organize the theft of the citizenry's assets by underhanded means in order to avoid having to enact politically unpopular measures.

Obviously this is a topic that is highly relevant to gold investors, as a result of a number of unique properties gold possesses. After all, governments cannot devalue it at will. In the longer term, they can only lessen investor appetite for gold if they institute policies that are the polar opposite of those that are characteristic of financial repression. Moreover, gold represents relatively mobile wealth, that nevertheless exists physically and does not depend on counterparty promises (including that most rapacious of counterparties, the State). As such it offers investors a means to protect themselves against financial repression, at least as long as its possession is legal (as we know from historical experience, there is no guarantee that it will remain so, even if it appears likely from today's vantage point).

The chapter on financial repression also makes clear why it is erroneous to compare today's vast public debt/ financial repression combination to that of the post-war period.

Another new feature in this year's report is the attempt to approach the valuation of gold from a quantitative standpoint. Specifically, a regression model that looks at probability-weighted scenarios of future Fed balance sheet trends strikes us as quite interesting. Of course, the value of gold is subjective, as are all values. Since it pays no stream of dividends (why that is the case is also explained in the report) and issues no financial statements, one cannot apply any of the valuation methods that are employed in valuing stocks or bonds. However, it is possible to ascertain gold's relative value versus a range of other investable assets and where it stands at a given point in time in the historical context. We were actually surprised to learn how moderately valued gold still is when looked at in this manner in spite of the advance since 1999/2000.